by Jim Stevens (JimStevens@aol.com)
Burlington, VT (May 25, 1999) -- Here in the "New and Improved Foolish Workshop," we continue to look high and low for the best predictors of successful stock selection. No single stock-screening criterion appears more often in the Foolish Workshop strategies than the one called Relative Strength. In one form or another, it's part of the criteria for selecting stocks in eight out of ten of the mechanical models we follow. In fact, Relative Strength was one of the original criteria set forth by the Gardners in The Motley Fool Investment Guide and is one of the factors included in our Foolish Eight Spreadsheet.
So what is this Relative Strength? Well, there isn't just one standard definition for Relative Strength. Different financial publications and researchers have created their own variants on a similar theme. In general, Relative Strength (RS) is a measure of the recent positive price performance of a stock. To put it very simply, stocks with high Relative Strength are the ones that have gone up the most in the recent past.
To confuse matters, you'll also run into an indicator devised by author J. Welles Wilder called Relative Strength Index (RSI). This is a measure of the recent acceleration of a stock's price, but relative only to itself -- not to other stocks. It is apparently used by short-term traders, but it is not one of the "relatives" of the RS measures used here in the Workshop.
Okay, so what specific flavors of Relative Strength are there? Well, there are quite a few, so I'll start by defining the two that are used by the Workshop screens. The one that is used the most frequently is called "Total Return-26 week," or some variation of that. It is simply the percentage return on the stock over the last six months, including dividends and adjusted for stock splits.
It would take forever to calculate this by hand for any significant number of stocks, but the trusty dataheads at Value Line come through for us. Each week they make available the 26-week Total Return. Total return is not a measure of Relative Strength all by itself, though. It becomes a measure of Relative Strength when various stocks are compared on the basis of their Total Return.
Here's how it works. With a few mouse clicks, a subscriber can select a list of stocks whose total return exceeds some value, say 20%, or he can select a list based on other criteria and then rank the stocks by their Total Return over the past half year. This is how the Foolish Workshop elves come up with many of the Workshop screens each week.
The other Relative Strength yardstick we keep in the Workshop toolbox is the Investor's Business Daily Relative Strength score. Every day, IBD measures each stock's relative price change over the last 12 months compared to all other stocks in their tables (all AMEX, NYSE and Nasdaq stocks). The most recent three-month period is given double weight. IBD then ranks all the stocks by that value. The top 1% are given the Relative Strength score of 99, the next 1% are assigned rank 98, etc., down to the lowest of the low, the stocks that have been beaten by 99% of all stocks -- rank 1.
Thus, a Relative Strength ranking of 90 from IBD tells you that the stock has done better than 90 percent of the stocks in IBD's stock tables. This 1 to 99 score makes for a nice "no math required" RS screening criteria, all for the price of a newspaper.
There are, of course, a number of different "time frame" variations to Relative Strength. Value Line reports Total Return for 4-week, 8-weeks, 13-week, one-year, two-year and all the way back to 10-year time periods. Comparing single stocks to market index performance is also a form of Relative Strength ranking I've seen widely published. But for our purposes, the Value Line and IBD numbers seem to be working quite well -- as one would expect in a strong bull market. At the moment, the two screens that rely most heavily on Relative Strength are the best-performing screens year-to-date.
Have a great week!
[NOTE: The weekly Rising Margins column has been discontinued. However, both the Margins screen and the Estimates screen will continue to be published each week.]